Days Payable Outstanding (DPO): Formula, Calculation, Example

The Accounts payable of an organisation represents the accumulated unpaid supplier balances. The days payable outstanding (DPO) is a financial ratio that indicates the average time the organisation takes to clear these supplier invoices. The longer the payment cycle is stretched, the longer the company can hold cash to meet its operational requirements.

In this article, we discuss the meaning and importance of days payable outstanding and the formula for calculating the days payable outstanding.

Meaning of Days Payable Outstanding

Days payable outstanding (DPO) refers to the financial ratio signaling the average number of days a company takes to pay outstanding invoices from its suppliers or vendors. It is usually calculated quarterly or annually to review how the company's cash flows are being managed. In simple words, the DPO is the average number of days between when a company receives its supplier invoices and pays them. 

For example, if a company's DPO is 75 days, it means that the company took 75 days on average for paying its suppliers. A high DPO is desirable as it frees up cash for other business objectives. However, this may not always be positive as it could indicate a cash shortfall and hence the inability to pay off its suppliers.

Objective of Finding Days Payable Outstanding

The days payable outstanding ratio provides access to the company’s accounts payable performance. Here are some of the objectives behind calculating a company's days payable outstanding:

1. Calculation of DPO is essential to manage a company's cash flows and improve its operational efficiency.
2. It enables the comparison of the DPO with other companies in the same industry to check if the company is paying its invoices too quickly or too slowly.
3. It helps check cash flows and make future projections.
4. It helps maintain an optimum balance between the accounts payable and accounts receivable of the company to ensure that the company has sufficient cash to serve emergencies and at the same time keep their suppliers happy.

Days Payable Outstanding Formula

DPO = (Accounts payable / Cost of goods sold) x 365 days

Here, accounts payable is the total amount of money that the company owes its creditors for purchases made. It can be taken from the balance sheet.

Cost of goods sold is the total cost incurred by the company to manufacture and bring the product to the market from where it can be sold. This number can be taken from the income statement of the company.

Days Payable Outstanding Example

ABC Limited is a furniture manufacturer purchasing raw materials from various suppliers. His accounts payable on the balance sheet was Rs.25,00,000. The company’s cost of goods sold was Rs.1,50,00,000.

Calculation of DPO is as follows:

DPO = (25,00,000/1,50,00,000) x 365 = 61 days

It means ABC Limited pays their invoices 61 days after receiving them on average.

Several factors, such as the type of industry, competitiveness in the market, etc., play a vital role in determining the DPO. 

Calculating DPO gives you the following insights:

1. Low DPO ratio: A low DPO indicates that the company makes quick payments to its suppliers or vendors and could be a sign that they are managing their cash flows effectively. However, it could also mean that the company has likely not negotiated their payment terms effectively. Such companies may have less liquid cash to meet other business obligations.

2. High DPO ratio: A high DPO indicates that the company is getting better credit terms and can take longer to pay its suppliers or vendors. Such companies have more liquid cash, which can be utilised elsewhere, such as producing more goods or managing other operations. However, in some cases with a high DPO, the suppliers may not favour delayed payments and hence refuse to do business or provide discounts.

Days Payable Outstanding Industry Average or Benchmark

The industry average for Days Payable Outstanding (DPO) refers to the benchmark or reference point from analysing the DPO of other companies within the same industry. This helps companies assess whether their DPO is in line with industry standards or needs to be improved upon.

The DPO industry average or benchmark is expressed in days. This indicates the average time taken for a peer company to pay their suppliers. For instance, the average DPO for a company in the automobile manufacturing industry may be 45 days. This benchmark is used to evaluate whether the DPO of an automobile manufacturing company, say XYZ Ltd., is lower or higher than the industry average. Enterprises can then identify their pitfalls and areas of improvement.

How to Improve Days Payable Outstanding (DPO)

Improving days payable outstanding depends on the goal of the company. For some companies, it could be to maximise their DPO to free up cash, but for other companies, it could be to reduce their DPO to take advantage of early payment discounts. 

There are various ways a company can improve its days payable outstanding. Some measures include-

1. Automating accounts payable: By automating accounts payable, companies can streamline their invoice and payment processing to become more effective and track payments and outstanding balances more effectively.
2. Comparing with other companies in the industry: It's helpful to gather data about the DPO of other companies in the same industry to check whether you're paying faster than your competitors and not optimally managing your cash flows, or paying too slowly and not getting the benefits of early payment discounts.
3. Effective negotiating: Effectively negotiating the credit terms with every vendor onboarded will help ensure that the DPO is optimum. While delayed payments free up the cash reserves for fulfilling other business objectives, companies must also ensure that they are still maintaining goods relationships with their suppliers.

Advantages of Calculating Days Payable Outstanding

There are several advantages to calculating the Days Payable Outstanding for a company. They include: 

1. Better cash flow management: Understanding the DPO provides finance leaders with insights into a company’s payables and thereby provides opportunities to optimise their cash flow. For instance, a low DPO may indicate that the company can request longer payment periods from their suppliers and preserve cash. 
2. Maintain better supplier relationships: Benchmarking DPO against the industry average helps companies understand the standard period it takes to pay suppliers in that particular industry. Aligning the DPO with the industry standard enables companies to maintain better supplier relationships, which helps negotiate better terms in future dealings.
3. Gain a competitive advantage: A DPO that is higher than the industry average may signify more efficient operations and that a company is managing their resources more effectively. This competitive edge reflects the company's proficiency in managing working capital and strategically allocating resources.
4. Identify areas of improvement: Calculating the DPO helps companies benchmark their performance against other peer companies in the same industry, thereby helping them identify areas of improvement.

Difference Between DPO and DSO

Days payable outstanding (DPO) is the average time a company takes to pay its suppliers while days sales outstanding (DSO) is the average time that customers take to pay their dues to the company. A high DSO is not favourable as it indicates that the company is taking too long to collect money from its customers. A high DPO can indicate two things, either that the company has negotiated excellent payment terms and utilising its cash flows effectively or that the company is poorly managing its free cash flows.